In the blink of an eye, my two favorite financial services stocks went from being perfect growth-at-a-reasonable-price stocks to being overvalued like every other stock in the market. For years, both Visa Inc (V) and Mastercard Inc (MA) had every quality I looked for in stocks.
They were part of an oligopoly with a high barrier to entry. If a bank wanted to offer credit card services, they had limited processor options. Visa and Mastercard had tons of cash on their balance sheets — as in, billions — and no debt. They generated billions of dollars annually in free cash flow.
Finally, they were growing earnings year after year at a rate exceeding 15%, but had P/E ratios of less than 15, making them great GARP stocks.
No longer. Two of those four elements are now gone. What happened, and when can you buy back into these stocks?
Visa Stock Is Too Expensive
Some time in 2014, Visa’s net income stumbled. V stock recovered, but that impacted its P/E ratio. Then V took on $15 billion in debt last year to buy back Visa Europe, which it spun off a few years earlier. To me, this signaled that V was getting worried about its ability to organically grow earnings, and had to buy up its European operations to maintain that same level of net income growth. I don’t like the move.
Today, V has about $5 billion in net cash, or only about $2.50 per share in cash. It now trades at 23x FY17 earnings of $3.29 per share. Long-term EPS growth is estimated at 15%. I’m willing to pay 18x or 19x for V stock because of its solid financials and brand name, but not 23x. For me to get interested again, Visa stock has to drop into the very low $60 range.
Mastercard Stock Is Also Too Expensive
Mastercard has been struggling with top-line growth. While it grew a perfectly respectable 14% in FY14, it only added 2.5% in FY15. That dragged net income growth down to 5%. MA stock still has 15% expected five-year annualized earnings growth, though.
MA has other problems, too. The EU may sue it for $24 billion dollars over transaction fees. That’s going to hurt. Even worse, a domestic settlement (with Visa included) of $7.25 billion was thrown out of court over a similar issue, so that’s another problem.
MA also took on additional debt, jumping from $1.49 billion to $3.3 billion. It has $8 billion in cash, but that’s not the cushion it once had years ago. Mastercard stock is also trading at 23x FY17 earnings, and like Visa stock, is deserving of 18x or 19x at best.
Based on that information, MA stock is not a buy until it falls at least $20 to around $70.
Bottom Line on Visa and Mastercard
The major factor to consider about both of these stocks is the pending lawsuits. Those cases will take a long time to settle, but they will impact the balance sheets. I don’t think they will cripple them by any means, since both companies generate billions in free cash flow. Still, the once-unbeatable team is faltering.
I think you should be careful here with both stocks. You may find market-beating returns elsewhere with less risk.
As of this writing, Lawrence Meyers did not hold a position in any of the aforementioned securities.
